The passwords are hashed (AFAIK), but the instance admin has effectively full control of any and all data originating on their instance, right down to the database level.
There has to be some level of guaranteed trust for any instance to work. And in some capacity there is inherent trust across the entire Fediverse that instances federating content are to be trustworthy. It's no different than any other forum from the old web days- there's zero guarantees and there's no way around it.